In its annual report (2008-09), the Reserve Bank of India looks at the complexity in framing monetary policy in the face of certain daunting challenges — increasing fiscal deficits of the Central government and the consequent huge rise in public debt, which may push up interest rates. Food prices, already a cause for serious concern, will be further aggravated by the failure of monsoons and the resultant drought conditions. Given this context, the report points out, it will be difficult to persist with the accommodative stance of monetary policy. Although headline inflation continues to be in the negative territory, various consumer price indices that accord a higher weightage to food remain high. The sizable wheat stocks procured after the last winter crop may not be sufficient to counter inflationary expectations. Rice-growing regions have been badly hit by the drought. However, a retreat from the loose monetary policy stance may not be possible immediately. This is because, in a situation of supply side shocks from food and petroleum prices, a tighter monetary policy — increasing interest rates and reducing liquidity — will not be effective in lowering inflationary pressures. Moreover, drought will mean demand contraction which will have to be countered through increased fiscal spending.

Although the global economic crisis shows signs of abating, individual countries are undecided about their strategies of exiting from their path-breaking monetary and fiscal stimulus packages that have served them well. At the recent meeting of finance ministers and central bank governors, held ahead of the scheduled Pittsburg G20 summit, it was suggested that the stimuli should continue for a while. This is because global economic recovery will be both slow and gradual. For India, reverting to the high growth path at the earliest and ensuring an inclusive growth process remain the top priorities of the government. The macroeconomic environment has to respond to the policy objectives. A near-term challenge for the RBI is to deal with the “unpleasant combination of subdued growth and emerging risk of high inflation.” That poses a complex dilemma. Tighter monetary policy might weaken recovery impulses, but continuing accommodation and faster expansion of money supply can only increase inflation. Having successfully insulated the domestic financial sector from the contagion, the RBI says that sound macroeconomic policies saved the day for India.

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